Promise Among Small Cap Gold Equities in West Africa

TORONTO –

The Gold Report: Mark, do you agree with Patricia Mohr, Scotiabank’s vice president of economics, that gold would need further reflation or another round of quantitative easing to rise above $2,000/ounce (oz) in the near term?

Mark Lackey: Higher inflation in the Western world would certainly help push gold over $2,000/oz in the next 18 to 24 months. But inflation is not the only factor underlying the price of gold. On the demand side, you have growing demand among the middle class in India and China. On the supply side, we are seeing that companies are not always getting to production as quickly as they anticipate. Given all of these factors, gold could top $2,000/oz even without a significant rise in the rate of inflation.

ML: The 7.5% number is actually China’s target rate. Looking back over the last 10 years, China has generally targeted its growth between 7% and 8%, and in almost every year, actual growth exceeded the target. In 2007, for example, the target was 8% and actual growth was 14%-an unusually big divergence. We think China will grow in the 8.5-9% range.

As to whether a weaker China would be good for commodities or gold, there are a few scenarios that have China growing only 4%. Clearly, that would have a negative impact on the price of commodities and the price of gold. But we do not believe that is a very likely scenario.

TGR: Where do you expect gold to trade this year?

ML: We put the low end around $1,600/oz and the upper end around $1,800/oz. We look at a trading range based upon a weekly average, but we see the price trending up as the year goes on.

TGR: You are a very seasoned observer of up and down markets with 30 years of experience. What are your observations on the gold market?

ML: Increasingly, gold is reacting to daily news more than other commodities. Changes in the European debt situation, a statement from Federal Reserve Chairman Ben Bernanke that differs from what the markets were anticipating, or numbers out of China and India that are stronger or weaker than expected-all this tends to move the gold market more on a daily basis than it did in the past.

We have also noticed greater strength from India and China as their middle classes grow. On the supply side, we see more economic nationalism. Some countries want a bigger slice of the pie. The result is often delays in getting gold mining projects into production.

TGR: Is economic nationalism here to stay?

ML: We saw a report the other day that listed 25 countries that the authors felt had become more nationalistic. I think economic nationalism lines up with a couple of things. One, some countries look at higher commodity prices and feel they should get a larger part of the revenues associated with these higher commodity prices. Two, in some countries you have opposition from environmentalists or the people who live nearby. I think this opposition will continue to rise in some parts of the world.

TGR: Will it be more prevalent in established jurisdictions or jurisdictions new to mining?

ML: One would anticipate more issues in the newer jurisdictions, but if you look around the world, even getting permits in parts of the U.S. is extremely difficult. Some states are very easy; others are quite difficult. Countries change over time. It has become easier to do business in some countries in the Americas. In others, political problems have created more difficult business conditions. The same is true in Africa.

Stability is in the eye of the beholder. You constantly have to stay on top of how countries and their regimes can change.

TGR: In late February, gold tumbled more than $100/oz in one day’s trading after Fed chairman Ben Bernanke dismissed the notion of a third round of quantitative easing. Should gold investors expect more one-day tumbles or price spikes for the foreseeable future?

ML: I would not consider that $100/oz move typical; it was a somewhat overblown reaction. However, there is more volatility in the commodity markets and in the markets in general than in the last 5 or 10 years. Investors will have to learn to live with that.

TGR: Is volatility driving investors out of the space? And if so, is that a mistake on their part?

ML: I think it depends on the type of investor. If people want no or little volatility, they can gravitate to other sectors. I used to be in the pipeline business, where there is little volatility and limited returns.

In the commodities sector, specifically the gold sector, I try not to look at daily movements. It is just noise. Day traders will react to all the daily events. If you are more of an investor, daily events should not influence your decision making.

We at Pope have a view as to where we think commodities and relative companies are headed. We look out to the next 3, 6 or 12 months, as opposed to reacting to daily events.

Is it a mistake to pull out? For any investor experienced in the mining and commodities sectors over the years, it would be a mistake to pull out. Other people with no experience in the mining sector have to determine their own risk preference and comfort levels.

TGR: The buy-and-hold strategy has changed. Trading in and out is now much more commonplace. Does buy-and-hold still work in the mining space?

ML: I would not necessarily advocate the old buy-and-hold strategy over the course of three to five years. The world changes so much that you have to be on top of all the changes that can occur and what they might mean for your investments.

Having said that, investors can find themselves whipsawed trying to react every day to every piece of news. Try to have a view that gives you a position you can stay with for a period of time such as three to six months. Then, make decisions based on how you now feel about the stock’s performance and where the markets are actually going.

TGR: You follow a number of small-cap gold equities, a handful of which have projects in West Africa. Despite their promising gold projects, many investors are wary of the added risk of operating in what are often perceived as unstable countries. Why do you and your colleagues at Pope & Company follow these opportunities in West Africa?

ML: It is a mistake to suggest that all African nations are unstable. Burkina Faso has had a democratically elected government since 1987; Mali since 1991. These two countries perform differently than countries without democratic principles and both countries are pro-mining, which makes it easier to develop mines in these two countries.

We like the stability of Burkina Faso and Mali. We particularly like that they are not on the list of countries where economic nationalism is on the rise. They have recorded low political risk in recent mining surveys compared to the rest of the world. As a consequence, we feel that dealing in Burkina Faso and Mali is superior to many other places in the world.

TGR: Any advice on strategies for playing companies located in Africa?

ML: It all goes back to risk tolerance and what people feel comfortable with.

What I have tried to communicate is that West Africa is one of the more stable parts of the world. Economic nationalism is not a problem. The topography is very positive; the projects are not 12,000 or 15,000 feet in the mountains with no infrastructure, no power and no water.

As to how to play West African mining stocks, we tend not to buy positions all at once. We generally take partial positions and stay on top of what is going on. Obviously, we follow the gold market and the gold companies. We watch where their drilling results are going and react accordingly.

TGR: Thanks for your time today, Mark.

Mark Lackey, investment strategist at Pope & Company Limited, has 30 years of experience in energy, mining, central and corporate banking and investment research and strategy. He worked at the Bank of Canada, where he was responsible for U.S. economic forecasting. He was a senior manager of commodities at the Bank of Montreal. He also spent 10 years in the oil industry with Gulf Canada, Chevron Canada and Petro Canada.